How have dividend heroes fared against inflation?

When it was introduced back in 2009, the Association of Investment Companies’ (AIC) Dividend Heroes concept was a stroke of marketing genius.

It highlighted the 19 investment trusts that had maintained or increased payouts to shareholders for more than 20 consecutive years, regardless of the ups and downs of the wider economy or the stock market. City of London Ord (LSE:CTY) led the pack (as it still does), with 42 years of increasing dividends.

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As Annabel Brodie-Smith, communications director at the AIC, explains, 2009 was a difficult year for income investors. “Interest rates were heading towards a (at the time) record low of 0.5% in March 2009, and many companies had been forced to cut severely or suspend their dividends.

“However, investment trusts had long records of consecutive dividend increases every year due to their unique income advantages, and we thought it would be helpful for investors to explain why.”

This led to the dividend hero campaign, showcasing the income reliability of this handful of trusts over the decades.

The income edge explained

So, why are investment trusts potentially a good bet for income investors? In a nutshell, unlike funds, they are not obliged to distribute to shareholders each year all the dividend income received from companies in which they invest.

They can hold back up to 15% a year to build a reserve fund, which they can dip into to top up payouts to investors in leaner years. In effect, investment trusts have significantly more control than their open-ended peers over the flow of dividend payouts over the long term. 

In the 15 years since launch, dividend hero status has become a badge of honour and a valuable marketing tool for the 20 or so trusts that have made it into the premier league list (the AIC has also launched a “new generation” league of trusts with more than 10 years of dividend growth).

• The 2024 line-up of ‘next generation’ trust dividend heroes
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But it is important to understand clearly what the term tells us about the trusts in the table – and what it doesn’t.

As Andrew McHattie, publisher of the Investment Trust Newsletter, observes: “The idea of buying shares from a list of heroic trusts that have somehow battled through regularly stormy seas to continue growing dividends for shareholders is highly appealing - but scratch beneath the surface, and all is not so clear-cut.”

To that end we asked research consultancy Quoted Data to crunch some dividend hero data for us (to 11 December 2024), and had a closer look at it. Each data point is the five-year annualised return. Over this period, inflation’s five-year annualised percentage figure is 4.51% – Consumer Price Index.

James Carthew, head of investment companies at QuotedData, flags the fact that this has been an unusual year for the recently merged mega-trust Alliance Witan Ord (LSE:ALW), one of the longest-running heroes and a seeming star of this year’s table in terms of its generous dividend boost.

“Alliance Witan’s dividend growth statistics (featuring annual growth of 13%-plus over five years) are inflated by its shift to an increased dividend, supported by transfers of capital,” he points out.

"In the run-up to the merger between Alliance Trust and Witan, the trust flagged that it would boost its dividend again.”

Significantly, Alliance Witan (yielding a modest 2.1%) is a good example of the wider observation that not all dividend heroes actually have a specific income focus.

Lower yields can lead to higher dividend growth

In fact, although nine of the 19 current table members are in income-oriented sectors (UK and global equity income, UK property), an equal number are members of the broad global or growth-focused UK and global smaller companies sectors.

Carthew sums up the overall dividend growth picture: “Generally, the fastest dividend growth tends to be delivered by the lowest-yielding trusts.” So, regardless of big percentage hikes in payouts, they won’t necessarily be the top choice for investors reliant on dividend income, because the actual dividends are not especially generous.

Seven of the top 10 trusts for rising payouts over five years yield less than 3% (as at mid-December). A prime example is Baillie Gifford’s Scottish Mortgage Ord (LSE:SMT), well-known for its dynamic growth-focused approach, which has delivered dividend growth averaging above 6%, soundly outpacing inflation in the process. But as McHattie comments: “Surely no one is buying it for income, not when the dividend yield is 0.4%.”

Lagging inflation over five years

Importantly, too, you shouldn’t assume dividend hero status necessarily means a trust’s dividend is keeping up with rising prices.

Average dividend increases from nine of the 10 highest-yielding trusts on the list, with yields ranging between 3.8% and 7.3%, have risen by less than inflation over the last five years, although admittedly prices have climbed sharply at times.

In total, only six out of 2024’s 19 dividend heroes have managed to outpace inflation during that period.

McHattie acknowledges that it’s not been easy to match the rocketing prices of recent years; nonetheless, he suggests, dividend hero status could be made a more meaningful achievement if it involved beating an inflation-linked target.

“The bar is set at a low level to keep managers’ spot on the coveted list,” he says. “Dividends can creep up marginally from year to year, and that is sufficient – even if it means your dividends are going down in real terms, after accounting for inflation.”

The single trust that can claim both a meaty (5%) current yield and inflation-beating growth (4.64%) over five years is JPMorgan Claverhouse Ord (LSE:JCH), housed in the UK equity income sector.

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Dividend payments are not the only consideration for income investors, of course. Many choose to take a total return approach, which means that they may consider harvesting a chunk of a trust’s capital growth to top up a relatively modest dividend payout.

A look at how the dividend heroes have fared against inflation in total return (TR) terms tells quite a different story. Only six trusts have underperformed when we look at net asset value TR, and they include all three UK smaller companies trusts and the property trust – both sectors that have endured particularly torrid times recently.

Seven struggle to beat inflation on a share price TR basis, with a couple of UK equity income trusts joining the doghouse. This is an area where decent returns have not been acknowledged by the market. (Although JPM Claverhouse fails in terms of both share price and NAV total returns, despite its attractive dividend yield.)

In other words, then, more than half the dividend heroes are able to beat inflation over five years, but not on the basis of dividend yield alone.

Only four – Alliance Witan, The Global Smaller Companies Trust Ord (LSE:GSCT), F&C Investment Trust Ord (LSE:FCIT), and Scottish Mortgage – outpaced inflation on all three performance measures. As Carthew points out: “As global trusts, these have been benefiting from the strong performance of the US market.”

Over other five-year periods where inflation has been less rampant, more dividend heroes will likely have been ahead of it. The key point is that just because a trust proclaims its dividend hero status does not guarantee it will preserve the real value of your dividend income. 

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There are other potential issues to bear in mind as far as the whole dividend heroes concept is concerned. First, keep in mind that the dividend heroes’ list looks at dividend growth alone and is absolutely not a measure of quality or overall returns. 

An obvious example is Athelney Trust Ord (LSE:ATY). It boasts 21 consecutive years of dividend growth under its belt, but has assets under management of just £4 million, wide dealing spreads and high management costs.

As McHattie observes: “It does not make the cut for serious comparative performance tables or for independent professional research, and its shares are down over five years, so it has not been a good investment despite its hero status.” Nor has it delivered inflation protection in either dividend growth or TR terms.

How many dividend heroes beat five-year annualised inflation figure of 4.51%?

Past performance is not a guide to future performance.

Are boards over-prioritising dividend winning streaks?

Another consideration is that because membership of the dividend hero club has become such a valuable attribute, there’s a danger of investment trust boards and managers making investment decisions driven in part by this marketing construct, rather than purely by investment considerations.

McHattie suggests that some boards “may have become fixated with the list, unwilling to sanction any risk-taking that could pose the slightest threat to the all-important dividend growth required to maintain the record.” 

At times, he adds, this may be reflected in “sub-optimal asset allocation”. He points to the fact that there is little correlation between the dividend heroes line-up and long-term investment performance tables.

Over 10 years, “arguably only Scottish Mortgage and Brunner Ord (LSE:BUT) Investment Trust have earned a spot on both lists”.

The dividend heroes’ concept is a great one, as a showcase of longevity and reliability; but it sheds only a narrow beam on the investment trust universe. However, it is no substitute for real research.